Rising house prices, not share prices, have been fuelling consumer spending. But for how much longer will prices go up?

IF AMERICA'S economy avoids sliding from downturn into a full-blown recession, it will be because the consumer continues to spend freely. Some economists had feared that this week's revised GDP figures would show that the economy had shrunk in the second quarter. Instead, consumer spending kept the figure positive—albeit at just 0.2% compared with the previous quarter at an annual rate.

Consumer spending, which accounts for two-thirds of economic activity, has remained strong despite falling share prices and rising unemployment for one main reason: a housing boom. Average house prices rose 8.8% in the year to March. New government figures, due this weekend, should still show an upward trend.

True, house prices have softened in areas most exposed to the “new economy” (remember that?), such as Silicon Valley, San Francisco and New York. There has also been a drop at the other end of the market: defaults on mortages on mobile homes have risen sharply. But, strange though it may seem, neither Manhattan apartments nor Arkansas trailer parks are representative of the country at large. According to the National Association of Realtors, the median existing-home price in the second quarter of this year was $146,900, up from $138,000 a year earlier.

Among metropolitan areas, Sacramento had the biggest price increase, up by 23.9% year-on-year, followed by Washington, DC, (18.6%) and the Bergen-Passaic area of New Jersey (17%). Regionally, the fastest growth is in the South, up by 10.2%, compared with 1.4% in the north-east. House sales nationwide are expected to reach record levels this year.

The housing boom fuels consumption in several ways. When people move, they tend to buy durable goods such as furniture, fridges and carpets. Lower mortgage rates—down to an average of 6.9% on a 30-year mortgage from 8.6% in May 2000—have prompted many homeowners to refinance on better terms, putting money in their pockets. After slowing down in recent months, refinancing has started to surge again in the past couple of weeks as mortgage rates have edged below 7%.

Higher house prices make homeowners feel wealthier and so more willing to spend. For all the attention given to the “wealth effect” on consumption of rising share prices, the housing wealth effect is better understood, stronger and more broadly based. The stockmarket's rise and fall mainly influenced spending by the richest Americans, who own most of the shares. But for most Americans, their house is their main asset. It has become easy for them to turn an increase in the value of a house into spending money by taking out a home-equity loan. And even though they have been doing that in droves, most estimates show total unrealised home equity has continued to grow.

Alan Greenspan, the chairman of the Federal Reserve, recently said that this unrealised capital gain was not “a depleting asset”. Paul McCulley, an economist at PIMCO, a bond fund-management firm, reckons that this was a hint that the Fed chairman would try to keep house prices rising, come what may. Can he do it?

Mortgage rates have not come down by much since January, when Mr Greenspan began his run of seven cuts in short-term rates. That may be because the market had already anticipated these cuts. But mortgage payments as a proportion of disposable income have edged up to 6.5%, from a low of 5.6% in 1994.

Charles Peabody of Ventana Capital, a research firm, points out that houses are taking longer to be sold and that there are more sales at below the asking price (the norm until recently was for the final price to be higher). Second homes and high-end housing are especially weak on these scores. “We are at the inflexion point,” Mr Peabody claims.

But the bulls have their own figures. Ian Shepherdson of High Frequency Economics, a research firm, says house prices will rise as long as interest rates do not. Currently, “it is an absolute no-brainer to gear up and buy a house,” because the rate of increase of house prices is higher than the mortgage rate. This has usually been a good leading indicator of further rises.

Might higher unemployment swell the number of houses being put up for sale and thus dampen prices? Only a bit, argue the bulls, because supply is so tight. In the past, housing booms have been killed only by rising mortgate rates, argues Mr Shepherdson. Nobody expects that to happen again soon. Hence the hope that the home-owning consumer will continue to spend the economy out of trouble for long enough for the corporate sector to sort out its problems. That may be what Mr Greenspan is betting on, too.